This article is part 2 of a series about choosing the proper form of entity to organize your business. Part 1 is available here and discusses common corporate entities. Part 2 focuses on some of the alternative entities available to organize a business. When making this decision, entrepreneurs and their advisors should, at a minimum, consider the type of business to be organized, the size of the business, growth plans, and capitalization.
Limited Liability Company (LLC)
Ownership
- One or more members (two or more if the LLC wants to be taxed as a partnership – most LLCs are treated as partnerships or disregarded entities for US federal income tax purposes)
- No restriction on types of owners – a member can be a separate entity
- Series LLCs may not be formed in California
Form of Equity
- Membership interest may be held by the members (may have more than one class of members)
Formation Document
- Articles of organization are filed with the Secretary of State
Governing Documents
- Requires drafting articles of organization and an operating agreement
- The operating agreement may modify default statutory provisions regarding governance
Liability
- A member or manager is generally not liable for the LLC’s debts, obligations, or other liabilities solely by reason of acting as a member or manager
Management
- You can choose to be member-managed or designate a manager
- Each member has equal rights to management with voting rights in proportion to the membership interest, unless otherwise provided by the operating agreement
Taxation
- LLCs do not have a specific set of tax rules that apply only to LLCs
- Most LLCs are treated as partnerships or disregarded entities for US federal income tax purposes, but they can elect C- or S-corporation status
General Partnership
Ownership
- There are at least two general partners
- No restrictions on types of owners
Form of Equity
- A partnership interest held by each partner
Formation Document
- No formal documents are required but typically a statement of partnership will be drafted
- You must file and publish a Fictitious Business Name statement in the county where the business is located
Governing Documents
- Partnership agreement
- The partnership agreement may modify default statutory provisions regarding governance with certain limitations
Liability
- All partners are jointly and severally liable for all partnership obligations unless otherwise agreed by the claimant or provided by law, except that a partner is not personally liable for partnership obligations incurred before becoming a partner
Management
- Each partner has equal rights to manage and conduct the business
- Unless otherwise provided in the partnership agreement, consent of all partners is required for acts outside the ordinary course of the business and when making any amendments to the partnership agreement
Taxation
- “Pass-through” entity for tax purposes – generally does not pay entity level tax
- Profits and losses are computed and allocated among the partners annually and pass-through to the partners who include their respective share of those items on their income tax returns (whether or not distributed)
- All trade or business income of a partnership generally is considered self-employment income to the partners and is subject to self-employment tax
Limited Partnership (LP)
Ownership
- Must have at least one of each of:
- General partner (responsible for management)
- Limited partner (typically silent investor)
- No restrictions on the types of owners
Form of Equity
- A partnership interest is held by each partner (may have more than one class of limited and general partners)
Formation Document
- A certificate of limited partnership of Form LP-1 must be filed with the Secretary of State
Governing Documents
- Drafting a partnership agreement
- Partnership agreement may modify default statutory provisions regarding governance with certain limitations
Liability
- General partners are jointly and severally liable for all LP obligations unless otherwise agreed by the claimant or provided by law, except that a general partner is not personally liable for LP obligations incurred before becoming a general partner
- A limited partner is generally not liable for the obligations of an LP
Management
- Each general partner has equal rights to manage and conduct the business
- Unless otherwise provided in the partnership agreement, consent of all partners is required for amendments to the partnership agreement
Taxation
- “Pass-through” entity for tax purposes – generally does not pay entity level tax
- Profits and losses are computed and allocated among the partners annually and pass-through to the partners who include their respective share of those items on their income tax returns (whether or not distributed)
Sole Proprietorship
A sole proprietorship is a natural person that directly owns the business. A sole proprietorship is not a legal entity separate from its owner and does not file a formation document with the California Secretary of State (SOS). The owner of a sole proprietorship is personally liable for all debts, obligations, and liabilities of the business, so it is discouraged as a form of business. While a sole proprietorship may have low start-up costs and an advantage with lenders because the owner is personally liable for business debts, this personal liability may create difficulty in raising capital.
Contact us for more information about how to best organize your business by e-mailing us at info@mnklawyers.com.
This material is provided for informational purposes only. It is not intended to constitute legal advice, nor does it create a client-lawyer relationship between MNK Law and any recipient. Recipients should consult with counsel before taking any actions based on the information contained within this material.
